The Organization for Economic Cooperation and Development is proposing what observers call the most significant restructuring of the international tax system in decades, including a single set of nexus rules and a global minimum tax.
The proposals are the result of Action One (of 15 action points) of the OECD’s “Inclusive Framework on Base Erosion and Profit Shifting,” which established a program to respond to what it calls the “Tax Challenges Arising from the Digitalisation of the Economy.”
The aim is to develop a consensus-
based solution for a group of 130-plus countries by the end of 2020. A policy note released in January 2019 included proposals made by members framed within two complementary pillars:
- “Pillar One: Reallocation of profit and revised nexus rules. This pillar will explore potential solutions for determining where tax should be paid and on what basis (‘nexus’) as well as what portion of profits could or should be taxed in the jurisdictions where clients or users are located (‘profit allocation’).”
- “Pillar Two: Global anti-base erosion mechanism. This pillar will explore the design of a system to ensure that multinational enterprises — in the digital economy and beyond — pay a minimum level of tax. This pillar is intended to address remaining issues identified by the OECD/G20 BEPS initiative by providing countries with new tools to protect their tax base from profit-shifting to jurisdictions which tax these profits at below the minimum rate.”
BEPS refers to the tax strategies utilized by multinationals to shift their profits from high-tax jurisdictions to low-tax jurisdictions, a practice the OECD aims to combat with the eventual consensus reached on its action points.
It all started in October 2015, according to Monika Loving, practice leader for international tax services at Top 10 Firm BDO USA. “The OECD has been working on the BEPS project since then. The goal is to come to agreement on a set of international global standards for how jurisdictions tax global companies,” she said. The discussion drafts for the pillars were released in October 2019 and November 2019.
Jumping the gun
While the OECD is seeking a consensus approach among its members, a number of countries decided to enact their own digital services tax without waiting for a consensus. Among these is France, which enacted its DST on July 24, retroactive to Jan. 1, 2019. And the U.K. has proposed — but not yet enacted — a DST that is similar to the European DST proposed by the European Commission.
In response to France’s enactment of its DST, the U.S. conducted an investigation under the Trade Act of 1974, which found that the French tax discriminates against U.S. companies, and is inconsistent with prevailing tax principles, which renders the tax particularly burdensome for affected U.S. companies. As a result, the administration is threatening duties of up to 100 percent on French champagne, cheese and handbags. France said it would go to the World Trade Organization to oppose such tariffs.
The possibility of individual countries enacting a DST is at odds with the OECD’s goal of a consensus-driven approach. In France’s case, it is a reflection of the difficulty in reaching a consensus, since it was undertaken after the EU failed to reach a consensus on a Europe-wide DST.
The Pillar Two (anti-base erosion) discussion draft sets out four suggested rules as to how a global minimum tax could be structured, according to Loving. “There will be very significant complexities in constructing the rules to accomplish this,” she said. “As it relates to digital businesses, it’s a very complex issue to determine where the profit arises. The concept of Pillar Two is to level the playing field between jurisdictions so there is not a tax advantage to locating a business in one jurisdiction as opposed to another.”
“One of the principles in its design is to take away the competitive aspect of tax in different jurisdictions,” she said. “Multinational entities are closely monitoring these developments.”
“The Pillar Two proposal consists of an income inclusion rule which would allow countries to impose a ‘top-up’ tax on the income of a company’s foreign branch or controlled entity if that income is subject to tax at a low effective tax rate,” said international tax attorney and CPA Selva Ozelli. “This would be complemented with an undertaxed payment rule which would deny a deduction or impose source-based taxation, such as a withholding tax on payments to a related party that are not subject to tax at a minimum rate. The Pillar Two minimum tax is designed to complement a Pillar One proposal that would allocate more multinational group profit to countries where a multinational’s customers or users reside.”
The forays by countries into levying their own DST have implications for both pillars, explained Pete Sepp, president of the National Taxpayers Union.
“As BEPS rolls on, we’re seeing other countries’ attempts to levy DSTs that have components that function as a minimum tax, if not global, then one that can cover large parts of global trade involving U.S. transactions,” he said. “So this is a good evaluation point for the BEPS project to consider how many of the drivers that initiated the process have lost steam and been addressed in other ways.”
“That doesn’t mean that countries levying a DST are taking the right approach,” Sepp said. “That may be an area where BEPS participants [the ‘Inclusive Framework’] should take the closest look, because if the concepts embodied in the DSTs being proposed in Europe are allowed to take root on their own, many of the harmonization concepts that underlie the BEPS project won’t ever flourish.”
“France’s assurance that it will comply with any BEPS consensus agreement is somewhat shaky,” he suggested. “You can envision a situation where one or more countries finds a provision distasteful and holds out for concessions that will make the BEPS framework worse. The disturbing paradox we have here is whether BEPS is allowed to proceed in stamping out a great deal of tax competition, or countries are allowed to go forward with rogue solutions of their own. Neither choice is appetizing.”
